Edgar Filing: Allied World Assurance Co Holdings, AG

AWH-2014.3.31-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________________

Form 10-Q

(Mark One)



þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: March 31, 2014



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-32938

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

(Exact Name of Registrant as Specified in Its Charter)



Switzerland	98-0681223
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification No.)

Lindenstrasse 8

6340 Baar

Zug, Switzerland

(Address of Principal Executive Offices and Zip Code)

41-41-768-1080

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer þ	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

As of April 14, 2014, 32,851,429 common shares were outstanding.

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TABLE OF CONTENTS



PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements	1

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	53

Item 4.	Controls and Procedures	56

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	57

Item 1A.	Risk Factors	57

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	58

Item 3.	Defaults Upon Senior Securities	58

Item 4.	Mine Safety Disclosures	58

Item 5.	Other Information	58

Item 6.	Exhibits	59

SIGNATURES		60

EXHIBIT INDEX

-i-

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PART I

FINANCIAL INFORMATION



Item 1.	Financial Statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

as of March 31, 2014 and December 31, 2013

(Expressed in thousands, except share and per share amounts)



	As of			As of
	March 31, 2014			December 31, 2013
ASSETS:
Fixed maturity investments trading, at fair value (amortized cost: 2014: $6,010,765; 2013: $6,065,350)	$	6,068,666		$	6,100,798
Equity securities trading, at fair value (cost: 2014: $803,954; 2013: $647,301)	834,893			699,846
Other invested assets	989,791			911,392
Total investments	7,893,350			7,712,036
Cash and cash equivalents	565,802			531,936
Restricted cash	144,570			149,393
Insurance balances receivable	839,630			664,731
Funds held	447,801			632,430
Prepaid reinsurance	331,065			340,992
Reinsurance recoverable	1,280,525			1,234,504
Accrued investment income	29,539			32,236
Net deferred acquisition costs	167,104			126,661
Goodwill	268,376			268,376
Intangible assets	48,198			48,831
Balances receivable on sale of investments	198,640			76,544
Net deferred tax assets	36,948			37,469
Other assets	82,617			89,691
Total assets	$	12,334,165		$	11,945,830
LIABILITIES:
Reserve for losses and loss expenses	$	5,856,798		$	5,766,529
Unearned premiums	1,627,658			1,396,256
Reinsurance balances payable	160,041			173,023
Balances due on purchases of investments	171,442			104,740
Senior notes	798,573			798,499
Dividends payable	16,495			16,732
Accounts payable and accrued liabilities	86,480			170,225
Total liabilities	$	8,717,487		$	8,426,004
Commitments and contingencies
SHAREHOLDERS’ EQUITY:
Common shares: 2014: par value CHF 12.30 per share and 2013: par value CHF 12.30 per share (2014: 33,821,752; 2013: 34,492,484 shares issued and 2014: 32,908,821; 2013: 33,417,882 shares outstanding)	410,820			418,988
Treasury shares, at cost (2014: 912,931; 2013: 1,074,602)	(68,756		)	(79,992		)
Retained earnings	3,274,614			3,180,830
Total shareholders’ equity	3,616,678			3,519,826
Total liabilities and shareholders’ equity	$	12,334,165		$	11,945,830

See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

for the three months ended March 31, 2014 and 2013

(Expressed in thousands, except share and per share amounts)



	Three Months Ended March 31,
	2014			2013
REVENUES:
Gross premiums written	$	901,393		$	837,081
Premiums ceded	(129,779		)	(142,029		)
Net premiums written	771,614			695,052
Change in unearned premiums	(241,329		)	(231,824		)
Net premiums earned	530,285			463,228
Net investment income	47,619			33,388
Net realized investment gains	54,205			79,637
	632,109			576,253
EXPENSES:
Net losses and loss expenses	275,286			255,178
Acquisition costs	67,722			56,685
General and administrative expenses	80,340			82,680
Amortization of intangible assets	633			633
Interest expense	14,534			14,134
Foreign exchange loss	49			2,518
	438,564			411,828
Income before income taxes	193,545			164,425
Income tax expense	16,573			5,433
NET INCOME	176,972			158,992

Other comprehensive income	—			—
COMPREHENSIVE INCOME	$	176,972		$	158,992
PER SHARE DATA
Basic earnings per share	$	5.33		$	4.59
Diluted earnings per share	$	5.23		$	4.49
Weighted average common shares outstanding	33,181,729			34,613,606
Weighted average common shares and common share equivalents outstanding	33,861,554			35,431,843
Dividends paid per share	$	0.500		$	0.375

See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

for the three months ended March 31, 2014 and 2013

(Expressed in thousands)



	Share Capital			Treasury Shares			Retained Earnings			Total
December 31, 2013	$	418,988		$	(79,992	)	$	3,180,830		$	3,519,826
Net income	—			—			176,972			176,972
Dividends	—			—			(16,489		)	(16,489		)
Stock compensation	—			11,236			(6,208		)	5,028
Share repurchases	—			(68,659		)	—			(68,659		)
Shares cancelled	(8,168		)	68,659			(60,491		)	—
March 31, 2014	$	410,820		$	(68,756	)	$	3,274,614		$	3,616,678

December 31, 2012	$	454,980		$	(113,818	)	$	2,985,173		$	3,326,335
Net income	—			—			158,992			158,992
Dividends — par value reduction	(12,981		)	—			—			(12,981		)
Stock compensation	—			17,465			(21,603		)	(4,138		)
Share repurchases	—			(36,245		)	—			(36,245		)
Shares cancelled	(5,412		)	36,245			(30,833		)	—
March 31, 2013	$	436,587		$	(96,353	)	$	3,091,729		$	3,431,963

See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

for the three months ended March 31, 2014 and 2013

(Expressed in thousands)



	Three Months Ended March 31,
	2014			2013
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income	$	176,972		$	158,992
Adjustments to reconcile net income to cash provided by operating activities:
Net realized gains on sales of investments	(49,756		)	(38,533		)
Mark to market adjustments	(13,956		)	(46,112		)
Stock compensation expense	4,240			3,995
Undistributed income of equity method investments	(2,292		)	—
Changes in:
Reserve for losses and loss expenses, net of reinsurance recoverables	44,248			5,278
Unearned premiums, net of prepaid reinsurance	241,329			231,824
Insurance balances receivable	(174,899		)	(156,967		)
Funds held	184,629			(34,212		)
Reinsurance balances payable	(12,982		)	(17,803		)
Net deferred acquisition costs	(40,443		)	(34,141		)
Net deferred tax assets	521			(2,157		)
Accounts payable and accrued liabilities	(83,745		)	(70,780		)
Other items, net	29,230			14,185
Net cash provided by operating activities	303,096			13,569
CASH FLOWS (USED IN) PROVIDED BY INVESTING ACTIVITIES:
Purchases of trading securities	(1,568,993		)	(1,330,735		)
Purchases of other invested assets	(779,934		)	(54,026		)
Sales of trading securities	1,494,648			1,188,307
Sales of other invested assets	663,237			97,989
Purchases of fixed assets	(2,336		)	(2,378		)
Change in restricted cash	4,823			116,785
Net cash (used in) provided by investing activities	(188,555		)	15,942
CASH FLOWS USED IN FINANCING ACTIVITIES:
Dividends paid - partial par value reduction	—			(12,981		)
Dividends paid	(16,732		)	—
Proceeds from the exercise of stock options	3,030			2,472
Share repurchases	(68,659		)	(36,245		)
Net cash used in financing activities	(82,361		)	(46,754		)
Effect of exchange rate changes on foreign currency cash	1,686			(2,055		)
NET INCREASE IN CASH AND CASH EQUIVALENTS	33,866			(19,298		)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	531,936			681,879
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	565,802		$	662,581
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	529		$	6,953
Cash paid for interest expense	$	18,750		$	18,750

See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

1. GENERAL

Allied World Assurance Company Holdings, AG, a Swiss holding company (“Allied World Switzerland”), through its wholly-owned subsidiaries (collectively, the “Company”), provides property and casualty insurance and reinsurance on a worldwide basis. References to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland.

2. BASIS OF PREPARATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements, including, but not limited to:


•	The premium estimates for certain reinsurance agreements,


•	Recoverability of deferred acquisition costs,


•	The reserve for outstanding losses and loss expenses,


•	Valuation of ceded reinsurance recoverables,


•	Determination of impairment of goodwill and other intangible assets, and


•	Valuation of financial instruments.

Intercompany accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the unaudited condensed consolidated financial statements.

These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

3. NEW ACCOUNTING PRONOUNCEMENTS

There were no recently issued accounting pronouncements that had a material impact on the Company's financial statements or disclosures.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

4. INVESTMENTS

a) Trading Securities

Securities accounted for at fair value with changes in fair value recognized in the unaudited condensed consolidated statements of operations and comprehensive income (“consolidated income statements”) by category are as follows:



	March 31, 2014				December 31, 2013
	Fair Value		Amortized Cost		Fair Value		Amortized Cost
U.S. Government and Government agencies	$	1,476,463	$	1,480,371	$	1,676,788	$	1,684,832
Non-U.S. Government and Government agencies	182,415		187,632		191,776		197,082
States, municipalities and political subdivisions	230,669		228,284		231,555		234,406
Corporate debt:
Financial institutions	1,097,649		1,083,131		958,794		943,518
Industrials	1,116,004		1,105,613		1,174,047		1,165,448
Utilities	96,807		96,403		69,426		69,658
Mortgage-backed	1,304,130		1,266,663		1,292,502		1,267,863
Asset-backed	564,529		562,668		505,910		502,543
Total fixed maturity investments	$	6,068,666	$	6,010,765	$	6,100,798	$	6,065,350



	March 31, 2014				December 31, 2013
	Fair Value		Original Cost		Fair Value		Original Cost
Equity securities	$	834,893	$	803,954	$	699,846	$	647,301
Other invested assets	839,987		718,358		764,081		658,683
	$	1,674,880	$	1,522,312	$	1,463,927	$	1,305,984

Other invested assets, included in the table above, include investments in private equity funds, hedge funds and a high yield loan fund that are accounted for at fair value, but excludes other private securities described below in Note 4(b) that are accounted for using the equity method of accounting.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

b) Other Invested Assets

Details regarding the carrying value, redemption characteristics and unfunded investment commitments of the other invested assets portfolio as of March 31, 2014 and December 31, 2013 were as follows:



Investment Type	Carrying Value as of March 31, 2014		Investments with Redemption Restrictions		Estimated Remaining Restriction Period	Investments without Redemption Restrictions		Redemption Frequency(1)	Redemption Notice Period(1)	Unfunded Commitments
Private equity	$	144,582	$	144,582	2 - 9 Years	$	—			$	262,450
Mezzanine debt	81,474		81,474		8 - 9 Years	—				182,562
Distressed	9,752		9,752		4 Years	—				5,249
Total private equity	235,808		235,808			—				450,261
Distressed	161,033		161,033		1 Year	—				—
Equity long/short	163,964		52,149		1 Year	111,815		Quarterly	30 -60 Days	—
Multi-strategy	122,584		—			122,584		Quarterly	45 -90 Days	—
Event driven	6,407		—			6,407		Annual	60 Days	—
Relative value credit	117,271		—			117,271		Quarterly	60 Days	—
Total hedge funds	571,259		213,182			358,077				—
High yield loan fund	32,920		—			32,920		Monthly	30 days	—
Total other invested assets at fair value	839,987		448,990			390,997				450,261
Other private securities	149,804		—			149,804				—
Total other invested assets	$	989,791	$	448,990		$	540,801			$	450,261



Investment Type	Carrying Value as of December 31, 2013		Investments with Redemption Restrictions		Estimated Remaining Restriction Period	Investments without Redemption Restrictions		Redemption Frequency(1)	Redemption Notice Period(1)	Unfunded Commitments
Private equity	$	144,422	$	144,422	2 - 9 Years	$	—			$	263,519
Mezzanine debt	64,627		64,627		8 - 9 Years	—				198,756
Distressed	7,776		7,776		4 Years	—				5,249
Total private equity	216,825		216,825			—				467,524
Distressed	151,227		151,227		1 - 2 Years	—				—
Equity long/short	99,365		—			99,365		Quarterly	30 -60 Days	—
Multi-strategy	136,958		—			136,958		Quarterly	45 -90 Days	—
Event driven	14,018		—			14,018		Annual	60 Days	—
Relative value credit	113,730		—			113,730		Quarterly	60 Days	—
Total hedge funds	515,298		151,227			364,071				—
High yield loan fund	31,958		—			31,958		Monthly	30 days	—
Total other invested assets at fair value	764,081		368,052			396,029				467,524
Other private securities	147,311		—			147,311				—
Total other invested assets	$	911,392	$	368,052		$	543,340			$	467,524

_______________________


(1)	The redemption frequency and notice periods only apply to the investments without redemption restrictions. Some or all of these investments may be subject to a gate.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

In general, the Company has invested in hedge funds that require at least 30 days’ notice of redemption and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund. Certain hedge funds have lock-up periods ranging from one to three years from initial investment. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a “gate.” The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process to reduce the possibility of adversely affecting investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash sometime after the redemption date. Certain funds may impose a redemption fee on early redemptions. Interests in private equity funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

The following describes each investment type:

•

Private equity funds: Primary funds may invest in companies and general partnership interests. Secondary funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, plus any remaining commitment, to secondary market participants. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

•

Mezzanine debt funds: Mezzanine debt funds primarily focus on providing capital to upper middle market and middle market companies and private equity sponsors, in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings and other corporate transactions. The most common position in the capital structure will be between the senior secured debt holder and the equity; however, the funds will utilize a flexible approach when structuring investments, which may include secured debt, subordinated debt, preferred stock and/or private equity. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

•

Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. Certain funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.


•	Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and by their targeted net long position.


•	Multi-strategy funds: These funds may utilize many strategies employed by specialized funds including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading.

•

Event driven funds: Event driven strategies seek to deploy capital into specific securities whose returns are affected by a specific event that affects the value of one or more securities of a company. Returns for such securities are linked primarily to the specific outcome of the events and not by the overall direction of the bond or stock markets. Examples could include mergers and acquisitions (arbitrage), corporate restructurings and spin-offs, and capital structure arbitrage.


•	Relative value credit funds: These funds seek to take exposure to credit-sensitive securities, long and/or short, based upon credit analysis of issuers and securities and credit market views.


•	High yield loan fund: A long-only private mutual fund that invests in high yield fixed income securities.


•	Other private securities: These securities include strategic non-controlling minority investments in private asset management companies and other insurance related investments that are accounted for using the equity method of accounting.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

c) Net Investment Income



	Three Months Ended March 31,
	2014			2013
Fixed maturity investments	$	36,299		$	32,525
Equity securities	3,253			3,199
Other invested assets	11,408			1,464
Cash and cash equivalents	439			488
Expenses	(3,780		)	(4,288		)
Net investment income	$	47,619		$	33,388

Net investment income from other invested assets included the distributed and undistributed net income from investments accounted for using the equity method of accounting for the three months ended March 31, 2014 and 2013.

d) Components of Realized Gains and Losses



	Three Months Ended March 31,
	2014			2013
Gross realized gains on sale of invested assets	$	62,292		$	44,249
Gross realized losses on sale of invested assets	(12,247		)	(6,965		)
Net realized and unrealized losses on derivatives	(12,920		)	(977		)
Mark-to-market gains (losses):
Fixed maturity investments, trading	22,455			(16,475		)
Equity securities, trading	(21,605		)	32,973
Other invested assets, trading	16,230			26,832
Net realized investment gains	$	54,205		$	79,637

e) Pledged Assets

As of March 31, 2014 and December 31, 2013, $2,635,901 and $2,894,401, respectively, of cash and cash equivalents and investments were deposited, pledged or held in trust accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, insurance laws and other contract provisions.

In addition, as of March 31, 2014 and December 31, 2013, a further $1,004,926 and $1,053,632, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facilities. See Note 10(d) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 for details on the Company’s credit facilities.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

5. DERIVATIVE INSTRUMENTS

As of March 31, 2014 and December 31, 2013, none of the Company’s derivatives were designated as hedges for accounting purposes. The following table summarizes information on the location and amounts of derivative fair values on the unaudited condensed consolidated balance sheets (“consolidated balance sheets”):



	March 31, 2014								December 31, 2013
	Asset Derivative Notional Amount		Asset Derivative Fair Value		Liability Derivative Notional Amount		Liability Derivative Fair Value		Asset Derivative Notional Amount		Asset Derivative Fair Value		Liability Derivative Notional Amount		Liability Derivative Fair Value
Foreign exchange contracts	$	194,081	$	1,408	$	117,757	$	3,145	$	294,788	$	6,254	$	122,439	$	1,176
Interest rate swaps	581,400		860		95,000		15		491,400		6,829		40,000		4,214
Total derivatives	$	775,481	$	2,268	$	212,757	$	3,160	$	786,188	$	13,083	$	162,439	$	5,390

Derivative assets and derivative liabilities are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following table provides the net realized and unrealized gains (losses) on derivatives not designated as hedges recorded on the consolidated income statements:



	Three Months Ended March 31,
	2014			2013
Foreign exchange contracts	$	(868	)	$	(744	)
Total included in foreign exchange loss	(868		)	(744		)
Put options	—			(3,732		)
Foreign exchange contracts	(558		)	1,815
Interest rate futures	(12,362		)	940
Total included in net realized investment gains	(12,920		)	(977		)
Total realized and unrealized losses on derivatives	$	(13,788	)	$	(1,721	)

Derivative Instruments Not Designated as Hedging Instruments

The Company is exposed to foreign currency risk in its investment portfolio. Accordingly, the fair values of the Company’s investment portfolio are partially influenced by the change in foreign exchange rates. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

The Company’s insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently the Company’s underwriting portfolio is exposed to foreign currency risk. The Company manages foreign currency risk by seeking to match liabilities under the insurance policies and reinsurance contracts that it writes and that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, the Company may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.

The Company also purchases and sells interest rate future and interest rate swap contracts to actively manage the duration and yield curve positioning of its fixed income portfolio. Interest rate futures and interest rate swaps can efficiently increase or decrease the overall duration of the portfolio. Additionally, interest rate future and interest rate swap contracts can be utilized to obtain the desired position along the yield curve in order to protect against certain future yield curve shapes.

The Company also purchases options to actively manage its equity portfolio.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:


•	Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.

•

Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.


•	Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

The following table shows the fair value of the Company’s financial instruments and where in the fair value hierarchy the fair value measurements are included as of the dates indicated below:



March 31, 2014	Carrying Amount		Total Fair Value		Level 1		Level 2		Level 3
Fixed maturity investments:
U.S. Government and Government agencies	$	1,476,463	$	1,476,463	$	1,135,246	$	341,217	$	—
Non-U.S. Government and Government agencies	182,415		182,415		—		182,415		—
States, municipalities and political subdivisions	230,669		230,669		—		230,669		—
Corporate debt	2,310,460		2,310,460		—		2,310,460		—
Mortgage-backed	1,304,130		1,304,130		—		1,170,069		134,061
Asset-backed	564,529		564,529		—		483,295		81,234
Total fixed maturity investments	6,068,666		6,068,666		1,135,246		4,718,125		215,295
Equity securities	834,893		834,893		800,107		—		34,786
Other invested assets	839,987		839,987		—		—		839,987
Total investments	$	7,743,546	$	7,743,546	$	1,935,353	$	4,718,125	$	1,090,068
Derivative assets:
Foreign exchange contracts	$	1,408	$	1,408	$	—	$	1,408	$	—
Interest rate swaps	860		860		—		860		—
Derivative liabilities:
Foreign exchange contracts	$	3,145	$	3,145	$	—	$	3,145	$	—
Interest rate swaps	15		15		—		15		—
Senior notes	$	798,573	$	906,448	$	—	$	906,448	$	—

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)



December 31, 2013	Carrying Amount		Total Fair Value		Level 1		Level 2		Level 3
Fixed maturity investments:
U.S. Government and Government agencies	$	1,676,788	$	1,676,788	$	1,370,088	$	306,700	$	—
Non-U.S. Government and Government agencies	191,776		191,776		—		191,776		—
States, municipalities and political subdivisions	231,555		231,555		—		231,555		—
Corporate debt	2,202,267		2,202,267		—		2,202,267		—
Mortgage-backed	1,292,502		1,292,502		—		1,145,164		147,338
Asset-backed	505,910		505,910		—		412,497		93,413
Total fixed maturity investments	6,100,798		6,100,798		1,370,088		4,489,959		240,751
Equity securities	699,846		699,846		625,942		—		73,904
Other invested assets	764,081		764,081		—		—		764,081
Total investments	$	7,564,725	$	7,564,725	$	1,996,030	$	4,489,959	$	1,078,736
Derivative assets:
Foreign exchange contracts	$	6,254	$	6,254	$	—	$	6,254	$	—
Interest rate swaps	6,829		6,829		—		6,829		—
Derivative liabilities:
Foreign exchange contracts	$	1,176	$	1,176	$	—	$	1,176	$	—
Interest rate swaps	$	4,214	$	4,214	$	—	$	4,214	$	—
Senior notes	$	798,499	$	897,601	$	—	$	897,601	$	—

“Other invested assets” excluded other private securities that the Company did not measure at fair value, but are accounted for using the equity method of accounting. Derivative assets and derivative liabilities relating to foreign exchange contracts and interest rate swaps are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

Recurring Fair Value of Financial Instruments

U.S. Government and Government agencies: Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

Non-U.S. Government and Government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.

States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S.-domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.

Corporate debt: Comprised of bonds issued by or loan obligations of corporations that are diversified across a wide range of issuers and industries. The fair values of corporate debt that are short-term are priced using spread above the LIBOR yield curve, and the fair values of corporate debt that are long-term are priced using the spread above the risk-free yield curve. The

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate debt are included in the Level 2 fair value hierarchy.

Mortgage-backed: Primarily comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine the appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Equity securities: Comprised of common and preferred stocks and mutual funds. Equities are generally included in the Level 1 fair value hierarchy as prices are obtained from market exchanges in active markets. Non-U.S. mutual funds where the net asset value is not provided on a daily basis are included in the Level 3 fair value hierarchy.

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value of the funds as reported by the fund manager that the Company believes is an unobservable input, and as such, the fair values of those funds are included in the Level 3 fair value hierarchy.

Derivative instruments: The fair value of foreign exchange contracts, interest rate futures and interest rate swaps are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

Non-recurring Fair Value of Financial Instruments

The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include investments accounted for using the equity method, goodwill and intangible assets. The Company uses a variety of techniques to measure the fair value of these assets when appropriate, as described below:

Investments accounted for using the equity method: When the Company determines that the carrying value of these assets may not be recoverable, the Company records the assets at fair value with the loss recognized in income. In such cases, the Company measures the fair value of these assets using discounted cash flow models.

Goodwill and intangible assets: The Company tests goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, but at least annually for goodwill and indefinite-lived intangibles. If the Company determines that goodwill and intangible assets may be impaired, the Company uses techniques, including discounted expected future cash flows and market multiple models, to measure fair value.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

Rollforward of Level 3 Financial Instruments

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):



Three Months Ended March 31, 2014	Other invested assets			Mortgage-backed			Asset-backed			Equities
Opening balance	$	764,081		$	147,338		$	93,413		$	73,904
Realized and unrealized gains (losses) included in net income	22,626			1,368			(864		)	(9,821		)
Purchases	89,199			14,110			7,493			—
Sales	(35,919		)	(17,956		)	(3,176		)	(29,297		)
Transfers into Level 3 from Level 2	—			—			606			—
Transfers out of Level 3 into Level 2 (1)	—			(10,799		)	(16,238		)	—
Ending balance	$	839,987		$	134,061		$	81,234		$	34,786
Three Months Ended March 31, 2013
Opening balance	$	655,888		$	167,825		$	62,246		$	54,680
Realized and unrealized gains included in net income	32,253			(1,189		)	(97		)	3,107
Purchases	73,210			—			2,461			—
Sales	(51,211		)	(21,645		)	(16,622		)	—
Transfers into Level 3 from Level 2	—			19,813			—			—
Transfers out of Level 3 into Level 2 (1)	—			(9,384		)	(7,085		)	—
Ending balance	$	710,140		$	155,420		$	40,903		$	57,787

_______________________


(1)	Transfers out of Level 3 are primarily attributable to the availability of market observable information.

The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, then such securities have been transferred to the Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. The Company obtains multiple quotes for the majority of its securities. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3, other than investments in other invested assets, are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

The Company records the unadjusted price provided and validates this price through a process that includes, but is not limited to, monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.

7. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:



	March 31, 2014		December 31, 2013
Outstanding loss reserves	$	1,474,376	$	1,520,867
Reserves for losses incurred but not reported	4,382,422		4,245,662
Reserve for losses and loss expenses	$	5,856,798	$	5,766,529

The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.



	Three Months Ended March 31,
	2014			2013
Gross liability at beginning of period	$	5,766,529		$	5,645,549
Reinsurance recoverable at beginning of period	(1,234,504		)	(1,141,110		)
Net liability at beginning of period	4,532,025			4,504,439
Net losses incurred related to:
Current year	324,147			299,248
Prior years	(48,861		)	(44,070		)
Total incurred	275,286			255,178
Net paid losses related to:
Current year	3,743			3,581
Prior years	228,594			241,121
Total paid	232,337			244,702
Foreign exchange revaluation	1,299			(5,198		)
Net liability at end of period	4,576,273			4,509,717
Reinsurance recoverable at end of period	1,280,525			1,163,503
Gross liability at end of period	$	5,856,798		$	5,673,220

For the three months ended March 31, 2014, the Company recorded net unfavorable reserve development in its U.S. insurance segment and net favorable prior year development in its international insurance and reinsurance segments. The net unfavorable prior year reserve development in the U.S. insurance segment for the 2011 loss year was in the Company's healthcare line of business and was due to adverse development on several claims above its previous expectations in the managed care errors and omissions class of business and higher than expected loss frequency in the medical malpractice class of business. The international insurance segment had favorable prior year reserve development for the 2007 loss year due to favorable development on an individual professional liability claim, and unfavorable reserve development for the 2013 loss year due to a single claim in the healthcare line of business. The net favorable prior year reserve development in the reinsurance segment for the 2013 loss year was primarily due to benign property loss activity.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

For the three months ended March 31, 2013, the Company had net favorable reserve development in its international and reinsurance segments due to actual loss emergence being lower than initially expected. The U.S. insurance segment had net unfavorable reserve development primarily due to adverse loss emergence trends for the 2011 and 2012 loss years for certain errors and omissions and directors’ and officers’ classes of business.

While the Company has experienced favorable reserve development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.

8. INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is a resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on the taxable equity of Allied World Switzerland. Allied World Switzerland has a Swiss operating company resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Assurance Company Holdings, Ltd (“Allied World Bermuda”) and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in Canada, Hong Kong, Ireland, Labuan, the United Kingdom, Singapore and Switzerland. To the best of the Company’s knowledge, there are no income tax examinations pending by any tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of March 31, 2014.

9. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:



	March 31, 2014		December 31, 2013
Common shares issued and fully paid, 2014: CHF 12.30 per share; 2013: CHF 12.30 per share	33,821,752		34,492,484
Share capital at end of period	$	410,820	$	418,988

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)



	Three Months Ended March 31, 2014
Shares issued at beginning of period	34,492,484
Shares cancelled	(670,732	)
Total shares issued at end of period	33,821,752
Treasury shares issued at beginning of period	1,074,602
Shares repurchased	670,732
Shares issued out of treasury	(161,671	)
Shares cancelled	(670,732	)
Total treasury shares at end of period	912,931
Total shares outstanding at end of period	32,908,821

During the three months ended March 31, 2014, 670,732 shares repurchased and designated for cancellation were constructively retired and cancelled.

b) Dividends

The Company paid the following dividends during the three months ended March 31, 2014:



Dividend Paid	Dividend Per Share		Total Amount Paid
January 2, 2014	$	0.500	$	16,732

On May 2, 2013, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution out of general legal reserve from capital contributions. The distribution amounts were paid to shareholders in quarterly dividends of $0.50 per share in July 2013, October 2013, January 2014 and April 2014.

c) Share Repurchases

In May 2012, the Company established a share repurchase program in order to repurchase up to $500,000 of its common shares. Repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position, legal requirements and other factors. Under the terms of this share repurchase program, common shares repurchased shall be designated for cancellation at acquisition and shall be cancelled upon shareholder approval. Shares repurchased and designated for cancellation are constructively retired and recorded as a share cancellation.

The Company’s share repurchases were as follows:



	Three Months Ended March 31,
	2014		2013
Common shares repurchased	670,732		432,117
Total cost of shares repurchased	$	68,659	$	36,245
Average price per share	$	102.36	$	83.88

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

10. EMPLOYEE BENEFIT PLANS

a) Restricted stock units and performance-based equity awards

Restricted stock units ("RSUs") vest pro-rata over four years from the date of grant. The compensation expense for the RSUs is based on the fair market value of Allied World Switzerland’s common shares at the date of grant. The Company estimates the expected forfeitures of RSUs at the date of grant and recognizes compensation expense only for those awards that the Company expects to vest. The forfeiture assumption is ultimately adjusted to the actual forfeiture rate.

Performance-based equity awards represent the right to receive a number of common shares in the future, based upon the achievement of established performance criteria during an applicable performance period. For the performance-based equity awards granted in 2014, 2013 and 2012, the Company anticipates that the performance goals are likely to be achieved. Based on the performance goals, the performance-based equity awards granted in 2014, 2013 and 2012 are expensed at 100%, 100% and 130%, respectively, of the fair value of Allied World Switzerland's common shares on the date of grant. The expense is recognized over the performance period.

The activity related to the Company’s RSUs awards is as follows:



	Three Months Ended March 31, 2014
	Number of Awards		Weighted Average Grant Date Fair Value
Outstanding at beginning of period	47,899		$	65.07
RSUs granted	151,392		100.68
RSUs forfeited	—		—
RSUs fully vested	(24,876	)	(65.06		)
Outstanding at end of period	174,415		$	95.98

The activity related to the Company’s performance-based equity awards is as follows:



	Three Months Ended March 31, 2014
	Number of Awards		Weighted Average Grant Date Fair Value
Outstanding at beginning of period	268,173		$	69.64
Performance-based equity awards granted	55,434		100.67
Additional awards granted due to achievement of performance criteria	34,965		61.51
Performance-based equity awards forfeited	—		—
Performance-based equity awards fully vested	(151,480	)	(61.51		)
Outstanding at end of period	207,092		$	82.52

b) Cash-equivalent stock awards

As part of the Company’s annual year-end compensation awards, the Company granted both awards classified as equity and cash-equivalent stock awards. The cash-equivalent awards were granted to employees who received RSUs and performance-based equity awards in tandem with stock-based awards. The cash-equivalent RSU awards vest pro-rata over four years from the date of grant. The cash-equivalent performance-based equity awards vest after a three-year performance period. The amount payable per unit awarded will be equal to the price per share of Allied World Switzerland’s common shares, and as such the Company measures the value of the award each reporting period based on the period-ending share price. The effects of changes in the share price at each period-end during the service period are recognized as changes in compensation expense ratably over the service period. The liability is included in “accounts payable and accrued liabilities” in the consolidated balance sheets and changes in the liability are recorded in “general and administrative expenses” in the consolidated income statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

The activity related to the Company's cash-equivalent RSUs and performance-based awards is as follows:



	RSU's					Performance-based Awards
Three Months Ended March 31, 2014	Number of Awards		Weighted Average Grant Date Fair Value			Number of Awards		Weighted Average Grant Date Fair Value
Outstanding at beginning of period	683,028		$	74.10		343,987		71.02
Granted	146,054		100.67			83,146		100.67
Additional awards granted due to achievement of performance criteria	—		—			34,965		61.51
Forfeited	(960	)	(77.72		)	—		—
Fully vested	(250,640	)	(64.41		)	(151,480	)	(61.51		)
Outstanding at end of period	577,482		$	83.81		310,618		$	82.52

c) Total Stock Related Compensation Expense

The following table shows the total stock-related compensation expense relating to the stock options, RSUs and cash equivalent awards.



	Three Months Ended March 31,
	2014		2013
Stock options	$	727	$	1,335
RSUs and performance-based equity awards	3,513		2,660
Cash-equivalent stock awards	4,629		12,756
Total	$	8,869	$	16,751

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

11. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share:



	Three Months Ended March 31,
	2014		2013
Basic earnings per share:
Net income	$	176,972	$	158,992
Weighted average common shares outstanding	33,181,729		34,613,606
Basic earnings per share	$	5.33	$	4.59



	Three Months Ended March 31,
	2014		2013
Diluted earnings per share:
Net income	$	176,972	$	158,992
Weighted average common shares outstanding	33,181,729		34,613,606
Share equivalents:
Stock options	487,986		482,207
RSUs and performance-based equity awards	188,537		335,575
Employee share purchase plan	3,302		455
Weighted average common shares and common share equivalents outstanding - diluted	33,861,554		35,431,843
Diluted earnings per share	$	5.23	$	4.49

For the three months ended March 31, 2014 and 2013, a weighted average of 25 and 333 RSUs, respectively, were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share.

12. SEGMENT INFORMATION

The determination of reportable segments is based on how senior management monitors the Company’s underwriting operations. Management monitors the performance of its direct underwriting operations based on the geographic location of the Company’s offices, the markets and customers served and the type of accounts written. The Company is currently organized into three operating segments: U.S. insurance, international insurance and reinsurance. All product lines fall within these classifications.

The U.S. insurance segment includes the Company’s direct specialty insurance operations in the United States and Canada. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. The international insurance segment includes the Company’s direct insurance operations in Bermuda, Europe, Singapore and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts from the Bermuda office and direct property and specialty casualty insurance to non-North American domiciled accounts from the European, Singapore and Hong Kong offices. The reinsurance segment includes the Company’s reinsurance operations in the United States, Bermuda, Europe and Singapore. This segment provides reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. The Company presently writes reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

Responsibility and accountability for the results of underwriting operations are assigned by major line of business within each segment. Because the Company does not manage its assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written.

Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio” and the “combined ratio.” The “loss and loss expense ratio” is derived by dividing

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “combined ratio” is the sum of the “loss and loss expense ratio,” the “acquisition cost ratio” and the “general and administrative expense ratio.”

The following tables provide a summary of the segment results:



Three Months Ended March 31, 2014	U.S. Insurance			International Insurance			Reinsurance			Total
Gross premiums written	$	269,945		$	134,364		$	497,084		$	901,393
Net premiums written	202,740			75,459			493,415			771,614
Net premiums earned	212,123			88,339			229,823			530,285
Net losses and loss expenses	(141,995		)	(23,566		)	(109,725		)	(275,286		)
Acquisition costs	(27,501		)	947			(41,168		)	(67,722		)
General and administrative expenses	(37,436		)	(24,761		)	(18,143		)	(80,340		)
Underwriting income	5,191			40,959			60,787			106,937
Net investment income										47,619
Net realized investment gains										54,205
Amortization of intangible assets										(633		)
Interest expense										(14,534		)
Foreign exchange loss										(49		)
Income before income taxes										$	193,545

Loss and loss expense ratio	66.9		%	26.7		%	47.7		%	51.9		%
Acquisition cost ratio	13.0		%	(1.1		)%	17.9		%	12.8		%
General and administrative expense ratio	17.6		%	28.0		%	7.9		%	15.2		%
Combined ratio	97.5		%	53.6		%	73.5		%	79.9		%



Three Months Ended March 31, 2013	U.S. Insurance			International Insurance			Reinsurance			Total
Gross premiums written	$	256,018		$	128,516		$	452,547		$	837,081
Net premiums written	192,253			77,745			425,054			695,052
Net premiums earned	188,439			84,214			190,575			463,228
Net losses and loss expenses	(133,324		)	(28,935		)	(92,919		)	(255,178		)
Acquisition costs	(23,128		)	849			(34,406		)	(56,685		)
General and administrative expenses	(39,596		)	(24,789		)	(18,295		)	(82,680		)
Underwriting (loss) income	(7,609		)	31,339			44,955			68,685
Net investment income										33,388
Net realized investment gains										79,637
Amortization of intangible assets										(633		)
Interest expense										(14,134		)
Foreign exchange loss										(2,518		)
Income before income taxes										$	164,425

Loss and loss expense ratio	70.8		%	34.4		%	48.8		%	55.1		%
Acquisition cost ratio	12.3		%	(1.0		)%	18.1		%	12.2		%
General and administrative expense ratio	21.0		%	29.4		%	9.6		%	17.8		%
Combined ratio	104.1		%	62.8		%	76.5		%	85.1		%

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

The following table shows an analysis of the Company’s gross premiums written by geographic location of the Company’s subsidiaries and branches. All intercompany premiums have been eliminated.



	Three Months Ended March 31,
	2014		2013
United States	$	520,773	$	478,443
Bermuda	229,631		228,672
Europe	103,336		86,509
Singapore	41,940		38,113
Hong Kong	4,883		5,344
Canada	830		—
Total gross premiums written	$	901,393	$	837,081

Europe includes gross premiums written attributable to Switzerland of $44,293 and $40,806 for the three months ended March 31, 2014 and 2013, respectively.

13. COMMITMENTS AND CONTINGENCIES

The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable under these proceedings are included in the reserve for losses and loss expenses in the Company’s consolidated balance sheets. As of March 31, 2014, the Company was not a party to any material legal proceedings arising outside the ordinary course of business that management believes will have a material adverse effect on the Company’s results of operations, financial position or cash flow.

The Company entered into a 20-year mortgage commitment with a Swiss bank for a company-used office building in Zug, Switzerland. The total proceeds to be received under the mortgage are CHF 18,000 with a fixed annual interest rate of 3.2% payable quarterly. The mortgage payments will be CHF 300 per year, plus accrued interest, for the first 19 years with the remaining balance payable at the end of the mortgage. The Company will receive the proceeds from the bank during the fourth quarter of 2014 at which time the Company will recognize the mortgage loan liability in its consolidated balance sheets.

In conjunction with the above mortgage commitment, the Company entered into a three-year credit facility with a Swiss bank that provides up to CHF 5,000 for general corporate purposes; however, the Company will use the proceeds from the credit facility to fund the purchase of the office building in Zug, Switzerland. The interest rate for the credit facility is 2.5%.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands, except share, per share, percentage and ratio information)

14. CONDENSED CONSOLIDATED GUARANTOR FINANCIAL STATEMENTS

The following tables present unaudited condensed consolidating financial information as of March 31, 2014 and December 31, 2013 and for the three months ended March 31, 2014 and 2013 for Allied World Switzerland (the “Parent Guarantor”) and Allied World Bermuda (the “Subsidiary Issuer”). The Subsidiary Issuer is a direct, 100%-owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees the senior notes issued by the Subsidiary Issuer.

Unaudited Condensed Consolidating Balance Sheet:



As of March 31, 2014	Allied World Switzerland (Parent Guarantor)		Allied World Bermuda (Subsidiary Issuer)		Other Allied World Subsidiaries		Consolidating Adjustments		Allied World Switzerland Consolidated
ASSETS:
Investments	$	—	$	—	$	7,893,350	$	—	$	7,893,350
Cash and cash equivalents	22,557		1,047		542,198		—		565,802
Insurance balances receivable	—		—		839,630		—		839,630
Funds held	—		—		447,801		—